Fragility Scorecard - how to avoid fragile companies

[abhikjha]

Hi all,

Recently I came across a YouTube video by Shankar Nath. He is SVP in ET Money and regularly posts the content on Investment, stock market, mutual funds etc. In this video, he is explaining the concept of fragility which is inspired by a series of blogs written by Mr. Vinnakota on his website called - Budget Tiger. Here is the link for his blog:

First Pillar of Investing - Avoid investing in Fragile companies - Introducing the Fragility Score Card: Financial Statement Analysis made easy (budgetiger.in)

How to Identify Fundamentally STRONG Stocks using the FRAGILITY Scorecard | Stock Selection Strategy

Basically, in the above video and in the blog above, concept of fragility is discussed and explained. Idea is to screen out fragile companies, over-valued and debt -ridden companies and companies where management has fragile mindset.

We all know that today’s world is very dynamic and extremely connected, thanks to Internet and plethora of information available on fingertips for investors. An unfavorable report in the US for an Indian company can severely impact the stock prices of that Indian company in our market here and vice versa. While we cannot avoid immediate extreme shocks to the company’s stock price by such unfavorable incidents but more often than not, the stock will recover in short to medium term if its more robust than fragile.

Mr. Vinnakota in his blog is contemplating four ways to determine if the company is fragile or robust:

1. Equity as % of total liabilities - higher the ratio, more robust the company is as its less dependent on the debt financing.

2. Breakeven sales as part of actual sales - lower the ratio, more robust the company. This ratio reveals the proportion of sales required to cover fixed and variable costs.

3. ROIC / ROCE - no brainer, higher the better

4. Cash flow from operations as a multiple of yearly debt obligations and replacement capex - higher the better. This ratio measures a company’s ability to generate sufficient cash flow to meet its debt obligations and cover interest and depreciation expenses.

Though, Mr. Vinnakota explains in his blog about filtering the stocks on percentile basis approach, I have tried to calculate the Fragility Scorecard in a different way. For each of the 4 metrics above, I have given a score of 1 if some thresholds are crossed. These thresholds are taken as values for 80th percentile in his blog.

Higher the score, the more robust the company is.

This Excel is the furtherance of the amazing work done by Mr. Amol on his forum:

FREE Excel Template for Screener.in - ValuePickr Forum

Now, let’s see the fragility scorecards for two companies (one extremely robust as per this framework and one extremely fragile):

1. Bharti Airtel
   Bharti Airtel.xlsx (376.1 KB)

Equity as % of total liabilities	0
Breakeven sales as % of total sales	0
ROIC	0
Yearly debt obligations as % of CFO	0
Total score	0

It has score of 0 which means extremely fragile company. Any bad news or incident can jolt it badly.

2. Andhra Paper
   Andhra Paper.xlsx (375.8 KB)

Equity as % of total liabilities	1
Breakeven sales as % of total sales	1
ROIC	1
Yearly debt obligations as % of CFO	1
Total score	4

Total score of 4 which means it’s very robust as per this framework.

Please note the caveats and disclaimer:

1. I have not invested in these companies, and these are not sell / buy recommendations.
2. I have just replicated this framework as per Mr. Vinnakota’s blog and Shankar’s YT video.
3. Results could be dynamic in nature and may change next year.

[Prabhat_Mohanty]

This fragility is predefined and mostly based on data. It is not dynamic. For example, innovative companies, companies with MOJO will not be reflected here , especially in initial years. There is also the case of Corporate Governance and other Shareholder unfriendly/ friendly companies.
I don’t know if there is any thread in VP on shareholder friendly/unfriendly companies on the basis of positives/ negatives. Such a thread will be of immense help to guide/ warn us.
Anyone can throw light on this?

[abhikjha]

Above framework can be used as a screener. I normally try to find companies which have good scores based on this framework. Once I do that and have bunch of stocks, I do the qualitative analysis on them which includes analysing growth potential, quality of management, any major corporate governance issues, guidance etc.

The other way it can be used to see how do the scores look like for companies you have in mind which have huge growth potential. If they have scored poorly but if you still have conviction, you can choose to ignore the poor scores and still invest in those stocks.

These screens will basically allow you to avoid companies which have low ROCE, huge debts, low debt paying capacity, huge proportion of sales required to cover fixed and variable costs. Such companies in the bull run may do good but as the situation gets worse, they are the ones who will be more fragile than others.

Hope it helps.